Norfolk Southern: Strong Dividends Set To Continue

Norfolk Southern Corporation (NYSE:NSC) is a Virginia-based company that controls a major freight railroad. Norfolk Southern is mainly engaged in the rail transportation of intermediate products, raw materials and finished goods largely in the East, Southeast and Midwest. The company also interchanges with rail carriers to and from the rest of the United States. Norfolk Southern provides comprehensive logistics services and offers the most extensive intermodal network in the eastern half of the United States.

Dividend History

NSC has long and illustrious history of dividends. The company has been paying attractive dividends for the past three decades. At the moment, the stock offers a dividend yield of over 3%. The company pays an annual dividend of $2 per share. NSC shares display attractive valuation metrics and strong profitability metrics. For instance, the current NSC stock price of $63.63 represents an annual dividend yield of 3.14% and price to book ratio of 2.1. On the other hand, the industry average for dividend yield and price to book ratio in the average in the transports sector is 1.8% and 3.9.

Dividend and Dividend Yield

Earnings

Over the past three years, NSC's revenues have demonstrated incredible growth. At the end of 2011, the firm reported revenues in excess of $11 billion up by 17% from the previous year. Railway operating expenses increased 16%, reflecting higher fuel prices and increased traffic volume. The railway operating ratio improved to 71.2%, as compared with 71.9% in 2010. NSC's 2011 net income rose 28% as a result of a 20% increase in income from railway operations.

At the end of the second quarter of 2012, the firm reported EPS of $1.60 for the quarter, beating the estimates of $1.52. The company's quarterly revenue was up 3% on a year-over-year basis. However, the guidelines for the third quarter were disappointing and affected the stock price significantly. NSC expects third-quarter earnings between $1.18 and $1.25 a share, while analysts had projected a per share income of $1.63. A decline in coal and merchandise shipments is expected to reduce revenue by about $120 million.

Additionally, fuel surcharge revenues are expected to be about $80 million below the year-ago levels. NSC generates about 30% of its revenues from coal supplies. Due to low gas prices, the demand for coal has declined, and the domestic utilities have turned to natural gas as a cheap alternative. However, natural gas prices will not remain low indefinitely. In fact, gas prices are expected to recover in the next two quarters, which should increase demand for coal. As a result, I believe the decline in revenues is temporary, and revenues will pick up soon.

Cash Flows

Cash flows from operations were $3.2 billion from the previous year. The company used cash to repurchase shares, dividend payments and debt repayments. In 2011, NSC repurchased 30.2 million shares at a total cost of $2.1 billion. NSC has repurchased and retired 109.6 million shares since 2006. At December 31, 2011, cash, cash equivalents, and short-term investments totaled $301 million.

In the last two years, the firm had free cash flows in excess of $1 billion. NSC paid cash dividends of $576 million at the end of the previous year. In the recent earnings announcement, the cash flows statement of the company showed cash dividends of $308 million for the first six months of the year. Moreover, share repurchase and retirement were $850 million. NSC follows a conservative and manageable payout ratio of 30%.

Debt

Long-term debt for NSC currently stands at $7.9 billion. In 2011, NSC debt was $7.3 billion; however, the company issued $600 million worth of senior notes yielding 3%. Most of the long-term debt for NSC is notes and debentures. The firm has $931 million worth of long-term debt maturing by 2016. However, the biggest amounts will fall in 2014 ($446 million) and 2016 ($500 million). All of the notes and debentures yield between 5.52% and 6.39%.

Peer Comparison

Norfolk

Union Pacific

CSX

Canadian Pacific

P/E

11.00

15.40

11.90

21.00

P/B

2.10

3.00

2.50

2.80

P/S

1.90

2.80

1.90

2.50

EPS Growth

6.40%

14.00%

11.00%

-5.10%

Operating Margin

30.10%

31.30%

29.60%

20.80%

Net Margin

17.30%

18.20%

15.80%

11.90%

ROE TTM

19.30%

20.00%

21.10%

13.10%

Debt to Equity

0.80

0.50

1.00

1.00

Source: Morningstar.com

Norfolk Southern's peers includeCSX Corporation(NYSE:CSX), Union Pacific Corporation (NYSE:UNP) and Canadian Pacific Railway Limited(NYSE:CP). Norfolk is trading at a discount as compared to its peers based on market multiples. Additionally, the company has remarkable margins and EPS growth rate. Only Union Pacific displays somewhat better margins than Norfolk, but it is trading at a substantial premium. The Debt to equity ratio for Norfolk is also impressive as compared to its peers.

Summary

Norfolk Southern Corporation has demonstrated impressive revenue growth and operating efficiency. The firm will face a short period of declining revenues, but the long-term operations of the company should not be affected. In addition, the company follows a conservative payout ratio coupled with adequate cash flow coverage. At the moment, I believe the dividends of the company are safe, and shareholders will keep enjoying healthy distributions. Furthermore, the firm has impressive metrics and attractive margins. The current discounted price provides a glorious opportunity to reap capital gains and a healthy dividend yield.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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